Part II

Running the Corporation Unit 5

FIDUCIARY DUTIES I: THE DUTY OF CARE

(risk taking vs. negligence · business judgment rule· waiver indemnification and insurance· oversight
liability)

Fiduciary duties

Fiduciary duties: Care (this unit) & loyalty (next unit)

Duty of care and protections against liability

Business judgment rule, waiver, indemnification, and insurance
What’s left of the duty?

Five cases
(1) Van Gorkom on breaching the duty of care
(2) Walt Disney on the modern contours of the duty of care
(3) Caremark, (4) Ritter, and (5) Citigroup on monitoring standards and oversight liability

Introducing Fiduciary duties

General principle. Fiduciaries occupy a position of trust; as such, they have a duty to act with care
and in the principal’s interest
Delaware corporate law imposes two fiduciary duties on directors, officers, and controlling
shareholders:

Duty of Care. Fiduciary must take care when acting on behalf of the principal; this covers
mistakes and un-conflicted transactions generally
Duty of Loyalty. Fiduciary must be loyal to the principal; covers self-dealing and conflicted
transactions

Who is the principal?

Introducing Duty of Care

Loyalty “merely” requires fiduciary to make a good faith effort to be a good custodian

Care requires more: The fiduciary must exercise the care of a reasonable person in similar
circumstances
Specifically, the corporate fiduciary must, e.g., Monitor the corporation; Make informed
decisions

Duty of care, in principle, covers every act of the fiduciary

Pro. Fiduciary must be vigilant. Con. May encourage

(inefficiently) conservative risk-taking. Why?
Preview & diction, no.1
Mergers and acquisitions
 Merger. Two companies combine into one. DGCL § 251
Acquisition. One company (“Buyer”) buys another (“Target”). Most acquisitions are structured
as a merger
Triangular merger
Mechanics. Buyer creates a subsidiary “shell” corporation, then merges the shell with Target.
Thus, after the merger, the Target becomes a "wholly owned sub" of Buyer
Consideration.
Target shareholders exchange their shares of Target for shares of Buyer, or for cash, or for some
combination; Target's stock is then canceled
Diction. “Reverse” if Target survives; “forward” if shell survives

Analysis

Forward vs reverse triangular merger

Why is reverse triangular more common than forward?
Since Target survives, Buyer retains the brand-name recognition of Target
Why choose acquisition rather than merger?
That is, why retain the target as a separate, wholly-owned subsidiary corporation? Why not just
merge the buyer and the target into one corporation?
Some reasons (of many): (1) Resale. Easier to sell later. (2)Governance. Separate board, etc. (3)
Limited liability.
Consider what happens when the acquired target later goes bankrupt?

Mergers and acquisitions

Voting
Merger. Merger is fundamental transaction; thus, it requires shareholder vote of both
corporations
Acquisition. Under certain common circumstances in acquisitions, the Buyer corporation does
not need to vote
Timing
The boards of each company negotiate a merger agreement (“signing”)
The corporation then solicits proxies and holds a vote(“closing”)
What happens between signing and closing? A lot!

Duty of Care Protection against liability

There are several protections against liability; they are:

Business judgment rule (“BJR”)

Waiver. DGCL § 102(b)(7)
Indemnification and insurance. DGCL § 145

Why protect against liability?

To promote risk-taking
Investor’s demand for risk-taking. Diversified shareholders want to encourage (rational)
risk-taking

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 Combating “corporate conservatism.” If directors face large personal liability for losses,
they may be overly-conservative Protection against liability

Business judgment rule

General principle (business judgment rule). The BJR is a presumption that a fiduciary satisfied
her fiduciary duties

Specifically, from Aronson v. Lewis (Del. 1984):

BJR is a “presumption that in making a business decision the directors of a corporation
acted on an informed basis, in good faith and in the honest belief that the action taken
was in the best interests of the company.”
What about officers?

Qualification. BJR only applies to a director that is “disinterested”

Standard of care. Under BJR, “director liability is predicated upon concepts of gross
negligence"

Policy (Business judgment rule)

Instead of BJR, why not this alternative (superior?) rule?

“Directors face personal liability if they do not act in the corporation’s benefit to the best of their
abilities”
Problem: It’s not administrable The “alternative” rule is essentially what is expected of
fiduciaries
But enforcing such a rule demands significant information and skill. E.g., What is the director’s
“true” ability?
BJR is thus a “second-best” rule. Meaning: If enforcement were perfect, it may not be the best
rule, but given imperfect enforcement, it may be the best rule

Smith v. Van Gorkom

Facts
Defendant-Van Gorkom (CEO and Chairman of Trans Union) negotiates a leveraged buyout
merger agreement with the Marmon Group (controlled by Jay Pritzker).Van Gorkom proposes
the agreement to the board; board approves and calls a meeting for shareholder vote.
Shareholders approve.

Procedure.

Plaintiff-shareholders of Trans Union Corp. seek rescission of the agreement; alternatively, they
seek damages against the Trans Union directors. Lower court for defendant-directors; instant
court reverses (!!)

Question, no.1
Was there evidence that $55 per share was unfair? No

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The problem, in a word, is procedure The price may have been “fair” – but that’s besides the
point because “the directors were given no documentation to support the adequacy of $55 price
per share”

What about $550 per share?

Question, no.2

What happened to the business judgment rule? Why did it not apply?
The presumption was successfully rebutted by plaintiffs “We conclude that Trans Union’s
Board was grossly negligent in that it failed to act with informed reasonable deliberation in
agreeing to [the sale]”
What could the board have done differently?
“Go through the motions”; Even if they know this is a great deal; Create the paper trail –
investment-banker evaluations, lawyer’s opinions, etc. – to prove that the decision was
informed

Takeaways
Aftermath and reinterpretations
The court presents this as a “standard” duty of care analysis; But is Van Gorkom actually an
early case about heightened standards in the takeover context? [See M&A chapters]
In any case, Van Gorkom is unlikely to be repeated, even on the same set of facts
Why would we want a higher standard of care in the context of a takeover (versus any other
business decision)?
O More at stake? Or the potential for self-dealing is higher? Directors might sell to a more
“friendly” buyer, or not at all in order to protect their own jobs. Was this the case in Van
Gorkom? [Sounds more like a loyalty problem]

Protection against liability Duty of care waiver

General principle

(§102(b)(7)). DCGL § 102(b)(7) enables a corporation to eliminate personal liability for breaches
of the duty of care
§ 102 (b) (7) of the Delaware Genaral Corpate Law Contents of certificate of incorporation.

(a)  The certificate of incorporation shall set forth: x x x

(b) In addition to the matters required to be set forth in the certificate of incorporation by
subsection (a) of this section,

the certificate of incorporation may also contain any or all of the following matters:
Xxx

(7)  A provision eliminating or limiting the personal liability of a director to

the corporation or its stockholders for monetary damages for breach of fiduciary duty as
a director, provided that such provision shall not eliminate or limit the liability of a
director:

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 (i) For any breach of the director's duty of loyalty to the corporation or its
stockholders;

(ii) for acts or omissions not in good faith or which involve intentional misconduct
or a knowing violation of law;

(iii) under § 174 of this title; or

(iv) for any transaction from which the director derived an improper personal
benefit.

A direct legislative response to Smith v. Van Gorkom. Accomplished through a charter

provision (which is common) Only for directors. What about officers?

Key limitation. A corporation may not waive liability: “(i) For any breach of the director's duty
of loyalty to the corporation or its stockholders” or “(ii) for acts or omissions not in good faith”

Policy and analysis

You’re a shareholder voting on a duty of care waiver, i.e., a rule waiving director liability for
gross negligence. Why would you vote to approve?

Some thoughts
(1) Second-best. Perhaps the enforcement problem is more profound – and so the “true”
second-best standard is not gross negligence, but intentional misconduct / knowing violation of
law (i.e., “bad faith”).

(2) Collective action problem. Perhaps this is a race-to-the- bottom: You vote YES only
because other companies have also waived care, and that’s the only way to attract and retain
directors

Protection against liability Indemnification and insurance

General principle (indemnification and insurance). DGCL§ 145 enables and sometimes mandates:

Indemnification. Corporation reimburses director for liabilities

Insurance. Corporation purchases insurance policy for directors; insurer pays out if director is
liable

DGCL § 145 (g)  A corporation shall have power to purchase and maintain insurance on behalf
of any person who is or was a director, officer, employee or agent of the corporation, or is or
was serving at the request of the corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise against any liability asserted
against such person and incurred by such person in any such capacity, or arising out of such
person's status as such, whether or not the corporation would have the power to indemnify
such person against such liability under this section.

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What’s the point?
Selection. Attract (risk-averse) and talented persons to serve on boards
Behavior. Promote (rational) risk-taking on the part of the board

Question, no.1
Which liabilities may be indemnified under 145? Must be indemnified? May indemnify good
faith acts, must indemnify a successful defense
D § 145(a) enables indemnification for liabilities resulting from D&O actions in good faith, while
§ 145(f) further enables bylaw amendments not inconsistent with § 145(a) D § 145(c) mandates
indemnification for attorney’s fees and reasonable expenses for successful defenses

Question, no.2
Indemnification and insurance
Which liabilities may be insured? Can a corporation purchase insurance to cover a liability it
cannot indemnify? Yes. Any liability can be insured
§ 145(g) provides gives the corporation “power to purchase insurance on behalf of any agent of
the corporation . . . whether or not the corporation would have the power to indemnify such
person against such liability under this section”

Insurance seemingly has no limits? Are there implicit limits?

How might these rules affect a director’s incentives to settle?

In re Walt Disney Co. Derivative Litig.

Facts

Eisner, CEO-Chairman of Disney, arranges to hire Ovitz. Ovitz’s employment agreement

includes significant “downside protection” in case Ovitz’s employment is terminated without
cause. Why? Ovitz is terminated without cause a little after a year, triggering a $130m severance
package
Procedure:

Shareholder-plaintiffs sue Ovitz, Eisner, and other members of Disney board, claiming breach
of fiduciary duties and contract. TC for defendants; Sup.Ct. affirms

Question, no.1
What duties did Ovitz owe to Disney?
When did he owe those duties? Plaintiff’s claim Ovitz had “apparent authority” before assuming
office – meaning?
Care and loyalty; owed after being hired
Apparent authority? Meaning, technically, that Disney Co. represented to the world that Ovitz
could act on its behalf before he assumed office.
Court rejects; Ovitz has no duty to act in the corporation’s interest while negotiating
employment agreement

Question, no.2
In re Walt Disney Co. Derivative Litig. Consider the 2nd claim against Disney defendants:
approval of the severance payout

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 (1) Did CEO-Eisner have authority to terminate Ovitz (without) board approval?
(2) Could board rely on GC’s advice w.r.t. whether Disney had a “for cause” termination case?
(1) Yes. For authority, first look to the corporate documents (which were ambiguous), then to
conduct (“extrinsic” evidence)
(2) Yes. Reliance on experts, in good faith.

Question, no.3
Did the board exercise due care when approving Ovitz’s employment agreement?
Yes. Court provides procedural guidance in the form of “best practice” suggestion
Substance? But, analysis also evaluates “fairness” (whether the severance package was “too
much”) – necessary?
Event study? Lower court highlights that Disney’s market cap increased by $1 billion when it
announced Ovitz was joining
Suggesting? Not a careless hire – but also not necessarily in good faith [These aren’t mutually
exclusive –

Question, no.4

What’s good faith?

Not bad faith- Which includes, but is not limited to: “an intentional dereliction of duty, a
conscious disregard for one’s responsibilities”
Can you both “take care” and “act in bad faith”?

HYPO: Make the plaintiff’s good faith argument?

Tactic: Demonstrate a failure to act in the face of a known duty to act – i.e., a dereliction of duty

Takeaways

In re Walt Disney Co. Derivative Litig.

Disney is the leading case for the contours of the duty of care and the meaning of good faith/
Care is here applied to an actual decision. According to the court, a failure to act in good faith
includes:
“Intentionally failing to act in the face of known duty to act, demonstrating a
conscious disregard for one’s duties” [bad]
Acting “with a purpose other than advancing best interests of corporation”
[worse]
Acting “with intent to violate applicable law” [worst]

How would the Van Gorkom court have ruled on this case? We may never know; tellingly, it was
not cited
Introducing Duty of care and oversight liability
General principle. “Oversight liability” cases cover instances in which the Board fails to
monitor the agents of the corporation
Typical fact pattern
Employee/agent of the corporation commits a legal wrong, resulting in liability for the
corporation

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 Directors were not directly involved in the wrongdoing, but the wrongdoing occurred “under
their watch”
Issue: Did directors breach their fiduciary duty of care?
Cases Allis Chalmers (red flags) (not in syllabus, but you should know)
We will cover: In re Caremark, Stone v. Ritter, In re Citigroup
In re Caremark Int’l, Inc.
Facts
Caremark Inc. is a health care services company. Company policy and federal law prohibited
payments to
doctors for referrals. Federal investigations into doctor kickback schemes led to fines and
settlements of approximately $250 million for Caremark.
Procedure
Caremark shareholders file a derivative claim against directors for breach of duty of care. In
this opinion, Delaware Chancery evaluates the “fairness and adequacy” of a proposed
settlement
Question, no.1
In re Caremark Int’l, Inc.
Did the court hold the directors breached or did not breach the duty of care?
And what result? Neither
This is a settlement hearing; the issue is whether to approve the settlement
The court concluded that: “there is a very low probability that it would be determined that the
directors of Caremark breached any duty to monitor or supervise”. Settlement approved

Types of duty of care claims

In re Caremark Int’l, Inc.

(1) “Directorial decisions”

Liability for losses that result from an “ill advised or ‘negligent’ decision”. In making a
determination, the court will not inquire into “the content of the decision that leads to a
corporate loss”. But it will inquire into “the good faith or rationality of the process employed”
to reach a decision

(2) “Failure to monitor”

Loss resulting from “unconsidered inaction” (I.e., oversight liability)

Question, no.2
How would this case have been decided under the Allis- Chalmers approach? Compare
Caremark approach? No liability
Allis-Chalmers advanced the “red flag” approach – that the directors had no duty to act absent
reasonable suspicion of wrongdoing
Allis-Chalmers was a lower bar
Caremark resists the generalization of this approach, and
instead insists that directors must actively monitor, even in
the absence of red flags. Why?
Question, no.3

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In re Caremark Int’l, Inc.. The court concludes that, with respect to the “lack of oversight” claim,
“the corporation’s information systems appear to have represented a good faith attempt to be
informed of relevant facts.” Make the argument?
Three facts to marshal (and frame as actively doing duty)
(1) System of compliance. “Caremark had an internal audit plan designed to assure compliance
[with business ethics and federal law]”
(2) Ongoing improvements. “Ethics committee adopted new policies”
(3) Reporting mechanism. Hotline to report suspected violations.
Remember: “only a sustained or systematic failure of the board to exercise oversight . . . will
establish the lack of good faith that is a necessary condition to liability” In re Caremark

Stone v. Ritter
Facts
AmSouth Bancorporation is a Delaware corporation. In 2004, AmSouth is assessed fines totaling
$50 million as a
result of state and federal investigations into a Ponzi scheme. Scheme was perpetrated by
Hamric and Nance, who used AmSouth as their bank
Procedure
Plaintiff-shareholder Stone files derivative suit against directors of AmSouth, alleging breach of
duty of care. Chancery dismisses. Supreme court affirms
Question, no.1
Is lack of good faith necessary for oversight liability? Yes. See Caremark, which this case
approves
What does a lack of good faith look like in oversight liability cases? A “failure to act in the face
of a known duty to act, demonstrating a conscious disregard for one’s duties.”
Caremark’s language in the context of oversight liability: “a sustained or systematic failure of
the board to exercise oversight – such as an utter failure to assure a reasonable information and
reporting system exists.”
Question, no.2
Is good faith a separate duty? Can a director be sued for only “breaching the duty of good
faith”? No
In Delaware, there are two fiduciary duties, a breach of which creates liability: Duty of care and
Duty of loyalty
Good faith is “merely” an element of both; an act in bad faith is a breach of the duty of loyalty
(more on this later)
Why is it important to know this? So that you draft the pleadings correctly; there is no cause of
action for bad faith

Question, no.3
What was the point of the KPMG report? Who is KPMG? Who hired them? What did the
report show?
The corporation (AmSouth) hired KPMG to review its internal system for monitoring
compliance
The report showed that such systems existed and were well- functioning – therefore refuting
the “systemic failure” claim that’s necessary for a successful oversight liability case
KPGM is a “Big 4” auditor (along with PwC, Deloitte, EY)

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Sarbanes-Oxley Section 404, requires that an internal control report that shall disclose the
“adequate internal control structure and procedures for financial reporting “ and “contain an
assessment” Requires management (typically CEO and CFO) to certify that they evaluated their
company’s financial reporting systems and disclosed any “material weakness”
Only companies that registered with SEC under SEA ’34. Effectively. Exposes CEO and CFO to
personal liability for securities fraud

In re Citigroup Derivative Litigation

Facts
Citigroup Inc. (and many other banks) suffers big losses because of exposure to the U.S. housing
market, particularly subprime mortgages
Procedure
Shareholders bring Caremark claim against directors of Citi. Dismissed

Question (and Takeaway)

Caremark demands the Board monitor – specifically by having a system in place so that
information can reach the board. What does the Citigroup case tell us about the nature of
precisely what the Board is trying to detect?
Employee misconduct
The affirmative duty of Caremark is to establish a system to detect employee misconduct – not
business risk generally
Should there be such a distinction? Aren’t they all “risk”?

Policy and analysis

What’s left of duty of care?
With so many protections against liability (BJR, waiver, indemnification and insurance) . . .
Duty of care is still a vehicle for regulation. The real power of a duty of care case is its effect on
subsequent behavior of directors of all Delaware corporations

Duty of care
Duty of care claims are based on the procedure of arriving at a decision (or non-decision).
Disney is the leading case for decisions and good faith.
For non-decisions, the Caremark standard requires a system of information gathering; Goes
beyond Allis-Chalmers’ “red flag” test; And is approved and refined in Stone v. Ritter, In re
Citigroup Good faith qualifies care (and loyalty) claims . . . And protections
It’s thus key to know what “good faith” means (!)
BJR presumes a director acted in good faith
§ 102(b)(7) and indemnification / insurance carve out bad faith

Part II
FIDUCIARY DUTIES I: THE DUTY OF LOYALTY

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 Duty of loyalty
(self dealing· disclosure and approval· controlling shareholders · corporate opportunities)

Duty of loyalty and conflicted transactions

Defined

DGCL §§ 144 (“safe harbor”) and 122(17) (waiving corporate opportunities)

Five cases

Cooke and Lewis on the limits of approval

Sinclair Oil and Weinberger on the controlling parent
Fliegler v. Lawrence on corporate opportunities & SH ratification

Duty to whom?
The duty is owed to the corporation. Cf. “shareholder primacy”

Duty of loyalty

General principle. Fiduciaries must act in the principal’s interest; they must not use the
principal’s assets for personal gain

In the corporate context, this duty becomes salient in two types of transactions:

Conflicted transactions. A transaction in which the corporate fiduciary has a personal interest
adverse to the corporation

Fundamental transactions. Transactions that change the relationship among shareholders and
management; e.g., M&A

Interested transactions: D/O

I. Conflicting Interest Transactions: Conflicting interest transactions are transactions

where the risk of self-dealing is particularly high. Conflicting interest transactions exist
where:

(1) the director is a party to the transaction;

(2) the director has a material financial interest in the transaction and is aware of this
interest; and
(3) the director knew that a “related person”—as defined by the Model Business
Corporation Act § 8.60—is a party or has a material financial interest in the transaction.

There is no absolute prohibition on conflicting interest transactions. In many cases,

these types of transactions are quite beneficial to the corporation affiliated with the
conflicted director. However, due to the significant risk of self-dealing these types of
transactions present, they must be approved or ratified in order to be valid.

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Safe Harbors: There are two primary “safe harbors” that can be invoked to validate a
conflicting interest transaction.

Primarily, the conflicted director can disclose to the board of directors:

(1) the existence and nature of the conflict; and

(2) all material facts known to the director (collectively, a “Required Disclosure”). After the
Required Disclosure, the board of directors may vote to approve the transaction. The
conflicted director may not take part in the vote or any discussions related to the
transaction. In the alternative, the conflicted director can make the Required Disclosure
to all shareholders; after which, the shareholders may vote to approve the transaction.
The shares owned by the conflicted director may not be considered in the vote.

Entire Fairness:
Minority Interested Shareholder who fails to get directors or shareholders approval
Majority Shareholder, who even with approval will still need to prove entire fairness.

A director who is part of a conflicting interest transaction but fails to gain the protection of one
of the safe harbors noted above may avoid liability if she can establish that the transaction was
objectively fair to the corporation at the time it was consummated. Transactions generally
qualify as being fair to the corporation when a fair price results (e.g., one that approximates fair
market value) after a fair negotiation process (e.g. one where there is no indication of self-
dealing or manipulation by the conflicted director).

Ratification: The board may ratify conflicted-interest transactions (and absolve the interested
director) if the interested director fully discloses the conflict. Some states also require that the
interested director prove the transaction was entirely fair to the corporation.

DGCL § 144 (“safe harbor”)

Rule.

Transactions between corporation and director or officer are not void (or voidable) solely
(i) for that reason or (ii) because the D/O participated in the meeting approving it Provided
that one of these is satisfied:

(1) Full disclosure + good faith authorization of majority of disinterested directors

(2) Full disclosure + good faith authorization of shareholders
(3) Transaction is “fair”

For § 144 purposes, interested directors can’t vote, but they can count toward establishing a
quorum
Interested transactions: D/O

Comparisons

Compare DGCL § 144 with . . .Regulation S-K Item 404 (Securities regulation Requiring
disclosure of “related party transactions”)

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R3d Agency § 8.06, which enables interested transactions so long as the agent:
Acts in good faith. Discloses all material facts to principal. Deals “entirely fairly” with the
principal

Cooke v. Oolie

Facts

Defendant-directors Oolie and Salkind vote yes on a transaction that allegedly protects their
personal interests as creditors (over those of equity shareholders). The other two directors, who
have no alleged personal interest, also voted yes

Procedure

Shareholders sue Oolie and Salkind; court grants discovery. Defendants move for summary
judgment; granted

Issue?
Question, no.1

What percent of disinterested directors approved? 100% (2 of 2)

So it sounds like DGCL § 144(a)(1) was satisfied? § 144 does not apply
Because: The transaction does not fall under the description given in § 144(a) preamble

However: The court recognizes this – and proceeds anyway as if it did apply

Question, no.2

What standard of review does plaintiff argue for? What does the statute require (presuming it applies)?
What standard does the court choose?

Plaintiffs want “entire fairness”; court chooses BJR

Does the statute require this selection? No.

Court expressly exempts an interested controlling shareholder from receiving BJR protection
(even if § 144(a)(1) is satisfied)

Why?

Analysis

Lewis v. Vogelstein

Recall from Agency, that the principal can ratify unauthorized acts of the agent.
Why is the situation different in the corporate context?

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The court offers three reasons: Collective action problem. There are many shareholders
authorizing the action; thus, multiple (conflicting?) principals Legal authorization. Ratification
is not always required; in such cases, it is merely evidence that the act was in (a majority of)
shareholders’ interests

D § 144 applies

Takeaways

Lewis v. Vogelstein

Result. Because of these differences, shareholder ratification does not have the same effect as a
principal’s ratification in agency law. Specifically, “shareholder ratification may be ineffectual

(1) because a majority of those affirming the transaction had a conflicting interest or
(2) because the transaction that is ratified constitutes a corporate waste” (only unanimous
ratification can authorize)

Definition (corporate waste). “An exchange of corporate assets for consideration so

disproportionately small as to lie beyond the range at which any reasonable person might be
willing to trade” Cf. nominal consideration Interested transactions (in summary)

Shareholder Ratification of Conflict Transactions

(a) General Rule. A director [§ 1.13] or senior executive [§ 1.33] who enters into a transaction
with the corporation (other than a transaction involving the payment of compensation) fulfills
the duty of fair dealing with respect to the transaction if:
(2) Either:
(D) The transaction is authorized in advance or ratified, following such disclosure, by
disinterested shareholders [§ 1.16], and does not constitute a waste of corporate assets [§ 1.42] at
the time of the shareholder action.

Standards, burdens, and voiding

Limit of 144. DGCL § 144 is a safe harbor from violability; it says nothing about the standard of
review applied if (a)(1) or (a)(2) is satisfied
(EF) If no disclosure + approval, then (a)(3) applies and the standard is entire fairness. Burden
on defendant
(BJR) If disclosure + good faith approval, review may be lowered from entire fairness to
business judgment rule with burden on plaintiff.
Presuming:
(1) In either board or shareholder approval, that there is no majority shareholder
(2) In case of board approval, that a majority of the board is not conflicted

Under the safe harbor statutes, the approval of the interested transaction by a fully informed
board has the effect only of authorizing the transaction, not of foreclosing judicial review.
Policy and practice

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Interested transactions

Policy arguments for and against business judgment rule protection? (1) For ex ante board approval? (2)
For ex post ratification?

(1) Ex ante: Collegiality & “capture” by fellow-board members.

(2) Ex post: Discourages ex ante disclosure; a fait accompli, a thing that has already happened,
leaving no choice but to approve.

Practice. Boards often form a “special committee” to approve conflict transactions. Ad hoc,
one-off committee of disinterested and independent directors to review and approve

Controlling shareholder
Controlling shareholders are corporate fiduciaries.
Establishing control. What does it take to “control”? One must own a “controlling” share of the
corporation
50% ownership. Per se control <50% ownership. Still possible to control (a practical test)

Cf. directors: What sets apart the “interested shareholder” from the “interested director”?

Interested shareholder legitimately pursues self-interest. Directors and officers do not

Sinclair Oil v. Levien

Facts
Defendant-Sinclair Oil Corp. owns 97% of a subsidiary, “Sinven”, which operates in Venezuela
Sinclair Oil controls the board of Sinven and caused it to:
(1) Distribute dividends totaling $108 million
(2) Form a contract with Sinclair; when Sinclair allegedly breached, it further caused Sinven
not to pursue a claim against Sinclair [Note: this is not in the casebook version]
Procedure
Plaintiffs-minority shareholders of Sinven sue Sinclair. TC for plaintiffs on (1) and (2); Sup ct.
reverses on (1)
Question, no.1
What is at issue? What do plaintiffs want? And defendants?
The standard of review for Sinclair’s acts. Plaintiff-minority shareholders want the “higher
bar” – entire fairness (or “intrinsically fair”, as the old court calls it)
Burden on defendant to show fairness. Defendant-Sinclair wants business judgment rule
protection. Burden on plaintiff to rebut BJR
Question, no.2
Which standard of review applies to the dividend declaration? Why? Business judgment rule
Because: The transaction was not self-dealing because the dividend payment is proportional

Entire fairness applies “benefit-detriment” when “the parent has received a benefit to the
exclusion and at the expense of the subsidiary [and thus its minority shareholders]”

Cf. The lower court’s application of fairness to the contract claim – which was not reversed.
Why? Dropping the claim benefitted the parent to the exclusion of the sub

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Weinberger v. UOP, Inc.
Facts
Signal Co., owner of 50.5% of defendant-UOP Inc., proposes to acquire the remaining 49.5%
through a “cash-out merger” with UOP Inc.
A majority of the minority shareholders approve at a price of $21 per share (approx. 50%
premium over market price)

Procedure

Plaintiff-Weinberger, minority shareholders of UOP Inc., challenge the merger, seeking

rescission damages. Chancery reviews fairness and finds for defendant. Supreme court reverses
and remands

Takeaway: Entire fairness review

Weinberger v. UOP, Inc. Burden shifting. Plaintiff first has burden to show basis for fairness
review. An informed vote by a majority of the minority shareholders can shield a transaction
from entire fairness review. Thus, Plaintiff can demonstrate a basis for entire fairness review
with a showing that the “majority of the minority” vote was not informed

Entire fairness. Defendant has burden to demonstrate by a preponderance of evidence:

Fair dealing. Process of transaction; negotiations, disclosure
Fair price. Amount paid; valuation of the company

Question, no.1
Why did the deal fail entire fairness review? Didn’t the majority of minority shareholders approve?
The majority of minority vote was not informed. Because: Arledge and Chitea, common
directors of both Signal and UOP, used UOP resources to arrive at the “maximum price” that
Signal should pay ($24) and then did not disclose that price

Goes to fair dealing

Lehman Brothers fairness report was “hastily” composed – and thus defective (also goes to fair
dealing)

Question, no.2

Could the directors of Signal and UOP have structured the transaction to avoid entire fairness review?
How?

Yes
UOP should have convened a special committee that excludes common Signal-UOP directors
Then let that committee negotiate the merger terms at “arms-length”

Tactic: Find the potential conflicts, then avoid them

Corporate opportunities doctrine

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General principle (corporate opportunities doctrine).
Corporate fiduciaries may not usurp a business opportunity that belongs to the corporation
because, in so taking, the fiduciary would exploit its position and compete with the corporation

Not a prohibition. A fiduciary can pursue even competitive opportunities given proper
presentation to board or shareholders; or if the corporation is “disabled” from taking the
opportunity

Waiver. The disclosure is effectively waivable via DGCL §122(17)

Policy
What are the policy pros and cons of § 122(17)? Renouncing an interest seemingly invites
competition directors – the very persons with access to your corporation’s information.

Why invite such competition?

Pros. Enables interlocking boards (Is that good?). Cons. Adverse selection: e.g., DreamWorks
SKG

Fliegler v. Lawrence

Facts
Defendants are: D&Os of both corporations: Agau and USAC. Collectively majority
shareholders of USAC. One defendant, Lawrence (president of Agau) personally acquired
“antimony properties” and offered to transfer to Agau. Agau is deemed unable to buy, and so
Lawrence creates USAC, a corporation, for the sole purpose of holding the land. Defendants
decide to grant Agau an option to acquire USAC holdings in exchange for 800k shares of Agau.
Agau exercises option 6 months later; approved by shareholders

Question, no.1
Which standard was applied to review the transaction? What (and when) is the transaction at issue?
Court applies entire fairness standard to the granting of the option.
What about the exercising of the option? Why not BJR?

§ 144(a)(2) is seemingly satisfied – but court says this doesn’t affect burden of proof because
“the majority of shares voting in favor . . . Were cast by defendants.”
Only 1/3rd of disinterested shareholders voted. So shouldn’t we look to whether a majority of
these voted
YES? Wouldn’t that give BJR protection to defendants?
Summary
Identification. To identify corporate opportunity in Del., apply the “line of business” test (Guft v.
Loft) with key factors

(1) How discovered? How the matter came to D/O’s attention

(2) Relevance? “Distance” to corp’s “core economic activities”
(3) How pursued? Use of corporate resources?

Defense 1 (Waiver). Either an express waiver via 122(17) provision or a board’s good faith
determination (upon presentation) to renounce opp. is a complete defense

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 Defense 2 (D/O’s good faith belief). D/O did not present, but she holds a good-faith belief that
the opportunity is outside the corporations “line of business” or that the corporation was
disabled (financially) from pursuing – this is risky.

Take home questions!

Fliegler v. Lawrence
(Claim.) Make the plaintiff’s claim that defendant(s) in Fliegler v. Lawrence breached the duty of
loyalty by usurping a corporate opportunity that belonged to Agau? What is the claim and against
whom? What additional information would you need?

(Remedy.) Suppose the Fliegler court orders an accounting.

What amount (in dollars) would the defendants have to return to Agau?
Disgorgement of profits
0 = Benefits – costs
0 = $1,200,000 – $250,000 (or the “lower end” of b/t $250 to $500k)

Whither we’ve been

Duty of loyalty. Duty of loyalty covers conflicted transactions. To bring such a case, you must
identify the conflicts. Hence the neutralizing power of special committees
Interested transactions. DGCL § 144 is a “safe haven” from voidability of deals between
corporation and D/O
Standard of review. Plaintiffs want entire fairness. Defendants want business judgment rule
Controlling shareholders. Sinclair and Weinberger in parent- sub relationships

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